The role of mark-to-market accounting was a debatable issue among the banks and financial services sector during the financial crisis of 2008/09. This was due to the requirements of the accounting standard which considers evaluating assets at fair value thus; many suggested the use of historical cost accounting to avoid any systematic risk to financial organizations. The purpose of this consulting report is to explore the concept of mark-to-market to determine the risk and benefits associated with this form of accounting method. The report also evaluates the accounting method for its effectiveness for reporting of asset values in general purpose financial statements in business. This report will serve as guidance in choosing mark to market for asset/liabilities valuation for the members of the Australian Shareholder’s Association.
From a long time, the accounting method of mark-to-market is being utilized by traders for significant tax advantages and to modify tax status of earnings from the capital to regular losses or income. Since 1997, the merchants have tallied the available holdings at marked prices on last day of financial year to adjust for losses and income for favorable tax purpose (Givoly et al., 2017). According to Amel-Zadeh et al. (2014), fair value accounting is referred to mark-to-market accounting reflect the standard practice in financial instruments. The use of this accounting is majorly seen by securities traders and by investors who trade commodities with borrowing money and used to price potential contracts. In this accounting type, the financial statement indicates changes in the market valuation adjustments in income statement and current market value of firm assets and liabilities in balance sheet thus, the reports show asset value for its current market price instead of book value. The advantage is in terms of pricing in this accounting as gives asset true value but in uncertain times it is associated with risk due to the variation in the asset value by surge of buyer and sellers.
The benefits associated with mart to market (MTM) accounting are for tax advantages through fully deductible losses and exemption from self-employment tax. In MTM, the income is taxed at a rate which is lower than capital gains. The losses are considered as ordinary and not capital losses with no capital loss limitation which remove all the losses and provide tax relief. Similarly, the capital gains are taken as ordinary gain and trader/investors remains free from tax related to its self-employment. On the other hand, the disadvantage of this accounting is that there is no carrying forward of the capital losses as these losses can be compensated by capital gains which under MTM is taken as ordinary income carryover. Thus, only a fixed sum could be used to offset the capital loss per year. In dealing with many contacts this accounting will not be elected as there will be loss of capital gain (long-term) on future contracts.
The supporters of MTM accounting are financial theorists, economist and several academicians due to the benefits related to true value of asset to provide a realistic and transparency of financial position of a firm. According to Zhang and Andrew (2014), the historic cost accounting does not offer accurate financial transparency. The financial theorist view the practice of mark to market accounting poses a regulation on the financial instruments and bull and bear market. Additionally, the supporters of MTM accounting view this accounting method as a self-correcting mechanism during declining market period to lower the firm risk and rising market will provide increased leverage in asset value. For instance, in balance sheet when market is declining the asset value get lower and drop down on left side where the MTM accounting will put an identical shrink in the equity capital and retained earnings on right side. The firm will reduce its ratio of debt to equity capital to cope with rigid capital requirement. The increase in asset value will be reflected for its ratio (leverage) in balance sheet in growing market condition. The banks with mark to market accounting will be in less risk than in mark to model system which allows the valuation on individual basis which does not provide a transparent view and cause absence of comparability and inconsistent account. The MTM provides transparency and consistency to financial organizations by assigning related value to comparable financial assets that are either internally generated or externally bought. Thus, assets in banks are valued from external market view.
On the different side, few theorists, regulators to banks and rating agencies argue MTM accounting intensified the financial crisis of 2008. The regulation of MTM led to losses in the financial institutions in terms of declined value of securities holdings, drop in credit rating and worthiness. This practice has also limited the borrowing capacity and directing into insolvency, in spite of no decrease in operating cash flow. Tasca and Battiston (2016) states that banks tracks a procyclical risk policies to increase leverage in economic developments and decrease the leverage in market contractions such as for hedge fund beta and economic performance assessment. The author states fair accounting contributes to systematic risk for balance-sheet ampliﬁcation mechanism and position risk in high value monetary-related asset, volatility risk of asset market and procyclical behavior in banks. At the time of financial crisis, the securities cannot be valued for financial institution especially banks in its balance sheet due to declining market condition. It can be noted that MTM in its market based measurement could not reflect the true value (selling price) of security asset of banks in volatile market conditions. The low investors confidence and low liquidity in the market can lower the value of asset than actual value of bank asset and a reduction in shareholder equity. To deal with this problem, in 2009 Financial Accounting Standards Board (FASB) relaxed the MTM rules and laid new guidelines to provide valuation of asset/liabilities based on a price in equilibrium market condition instead of a forced liquidation of assets or bank securities to generate liquidity in volatile market (Jiang et al., 2015).
Moreover, the application of risk management strategies and use of complex financial instruments requires current cost and not historical cost for a more accurate and reliable financial reporting. It can be noted that fair value usefulness for reporting asset values is to bring more clarity, relevance, reliability and meaningful financial statements. Accountants and investors view that selected assets/liabilities reveal current valuations in fair market model that brings accuracy in financial reporting and is useful for useful to investors, creditors and other resource allocation decisions. It uses time-specific information and current market conditions, to offer relevant value for a firm and guides corrective actions. However, Magnan et al. (2015) argues that execution of MTM is difficulty due to standard-setting measurement and the fair market value disclosure can lead to yearly rise in tax estimations. It can be said that adapting to MTM fair value reporting system demands financial entities to modify business risk strategies and corporate policies.
The use of mark to market accounting method is for its potential benefits of tracking wash out sale, to deduct the losses for new financial year and for tax advantages. The MTM method has been largely criticized during the economic collapse of 2008/09 but the supporters argue this fair value accounting model to be a feasible selection for valuation of most financial assets ignoring the short-term changes and systematic or volatility risk for the long term effect and credibility, transparency and reliability of the mark-to-market accounting in financial reporting. Thus, there is a need for regulators, banks and other financial organizations to establish a transparent accounting standard and reporting.
Amel-Zadeh, A., Barth, M. E., & Landsman, W. R. (2014). Procyclical leverage: bank regulation or fair value accounting?. Rock Center for Corporate Governance, Working Paper, 147.
Givoly, D., Hayn, C., & Katz, S. (2017). The changing relevance of accounting information to debt holders over time. Review of Accounting Studies, 22(1), 64-108.
Jiang, J., Wang, I. Y., & Xie, Y. (2015). Does it matter who serves on the Financial Accounting Standards Board? Bob Herz’s resignation and fair value accounting for loans. Review of Accounting Studies, 20(1), 371-394.
Magnan, M., Menini, A., & Parbonetti, A. (2015). Fair value accounting: information or confusion for financial markets?. Review of Accounting Studies, 20(1), 559-591.
Tasca, P., & Battiston, S. (2016). Market procyclicality and systemic risk. Quantitative Finance, 16(8), 1219-1235.
Zhang, Y., & Andrew, J. (2014). Financialisation and the conceptual framework. Critical perspectives on accounting, 25(1), 17-26.
Major factors such as business dynamics, increased awareness of social system, government regulations and ecosystem degradation pose a considerable pressure on the companies to fulfill its sustainable goals. This demand the companies to provide transparency in reporting of both financial and non-financial aspects thus, as a result the trends of sustainability reports have gained much relevance for modern companies. Most of companies for sustainability reporting adopt the framework as per the GRI guidelines that provide reference, principle and indicators for the companies to assess and report the triple bottom line of sustainability issue i.e. social, economic and environmental positive and negative contributions. This consulting report focus on the model of sustainable development to determine the cost of adopting global reporting initiative (GRI) standards for sustainability reporting of the company for its economic, social and environmental impacts. The report also identifies the benefits of GRI standards to the company from an accounting theory perspective for sustainability accounting and financial reporting. This report will be provided to the company board of directors to form a basis for to measure the impact of adoption of GRI standards for sustainability accounting and financial reporting system.
Companies have realized the importance of sustainability reporting for its shareholders and stakeholders and thus, using it as a driving force in business growth strategy. This is useful in monitoring of non-financial aspects like social and environmental cost for the boards of directors to improve the awareness of opportunity and risk factors for such as financing options, innovation, ethical reputation, investor confidence, etc, that impacts the company performance. There are various frameworks such as UN Global Impact, ISO 26000, OECD, GRI, etc. available for company for sustainability reporting (Rahdari and Rostamy, 2015). The widely used guidance for sustainability reporting is GRI standards. In GRI based reporting, the standards focus on sustainability framework, stakeholder management, materiality and totality (Fonseca et al., 2014).
The companies adopt reference of global reporting initiative (GRI) standards convey out that these standards have introduced discipline in reporting of economic, social and environmental, performance. According to Hahn and Kühnen (2013), the benefits of GRI sustainability reporting assist a management to reflect upon sustainable goals and define its vision to different internal and external stakeholders. It can be said that adoption of GRI standards enhances awareness of sustainable practices across the entire organization. The GRI reporting guideline such as G4 has a central focus on the materiality concept for the triple bottom line for sustainability reporting. Moreover, the process of reporting under GRI includes feature of verification and assurance to encourage effective sustainability reporting in G3 guideline. Thus, it can be noted that an understanding of the GRI guidelines will help the company management to develop effective communication plan to suggest and reflect on the sustainability efforts that will encourage compliance to global standard and provide comparability across similar companies. However, de Villiers et al. (2014) points that adoption of GRI reporting require that company to identify the disclosures requirements under GRI reporting standards considering the stakeholder engagement. The proponents of GRI referenced reports claims several benefits for the company. The disclosure of social, environmental and economic aspects has lead to brand reputation in social system, employee loyalty and reporting benefits has impacted company balance sheet and increased stock price and improved access to capital for the company CSR reporting (Fernandez-Feijoo et al., 2014). It can be noted that publishing of sustainability efforts indicates company quality and reduces the cost of equity in competitive markets. It also provides transparent information to investors and creditors to associate with cash flow from business operations and return on assets. Moreover, identification of risk factors leads to cost reduction through improvements in business practices by considering social and other external factors and opportunity leads to innovation and new learning for cost savings. Several regulators also viewed the sustainable report under the GRI framework allows the company to reflect on the constructive and negative contributions for further improvement to achieve objective of sustainable development in its company vision. The more credible financial reporting is possible by adoption of GRI guidelines which can help the company management to measure the growth and development aspects related to CSR reporting in terms of consistency, relevance of cost associated with social and environmental activities which is difficult to identify and more importantly it will provide a more reliability to nature of CSR reporting.
On the opposing side, there is cost associated with the adoption of GRI standards for reporting which pose a barrier to adopt GRI referenced sustainability reporting. Sustainability accounting focus on the accountability of company interaction with social system and external factors but it is a challenging task to put these policies together to promote sustainability goals. Vigneau et al. (2015) argues that firms face difficulty in maintaining the requirements of the GRI standards to provide a precise reflection of sustainability efforts. The rising standards of the GRI reporting is also challenging for companies to develop reporting with a risk of misstated information in financial statement in context of stakeholder engagement/management. This is linked to the cost of credibility of corporate financial reporting and reputation risk in the market. There is huge cost associated with the information or data gathering process and obtaining relevant social and environmental cost to reflect true value for sustainability accounting for a better CSR reporting and increased accountability towards its stakeholders. The disclosure of information might draw away potential investors during initial public offering due to stock exchange risk leading to competitive disadvantage for companies. Alonso‐Almeida et al. (2014) states the report generation in reference of GRI standards by some companies is considered as a cost and time expenditure and other overheads for seeking expertise for understanding of the standard requirements for sustainability reporting. The standards also require the fulfillment of certain benchmarks for improvement in the transition period which put a burden on the company resources. Additionally, the requirements and objectives of the GRI based reporting pose a challenge to the companies to align with the stakeholder interest (Fernandez-Feijoo et al., 2014). Vigneau et al.(2015) state the consequences of adopting GRI reporting standards has an influence on the choice of CSR activities and related performance and focus more on the top-down approach of corporate structure.
It can be concluded that companies adopting for GRI reporting guideline has used it as a tracking tool to monitor performance, identify risk factors and opportunities and to measure the social, economic and environmental cost as per the indicators outlined in the guidance. This has helped the firms to incorporate the sustainability practices as a business culture and for growth strategies. This has also led to cost reduction and encouraged innovation aspects through stakeholder engagement. However, additional cost is related in terms of time, cost and proficiency of the accountants to gather relevant data related to economic, social and environmental cost to fulfill the requirement of CSR reporting and to provide transparent and reliable financial reporting for better understanding of the contribution of business to the creditors, investors, regulators, other shareholders and social system. It can be noted that for a proper sustainability accounting and reporting framework, the implementation of GRI can assist company management to device appropriate corporate responsibility strategy with a reliable financial reporting system.
Alonso‐Almeida, M., Llach, J., & Marimon, F. (2014). A closer look at the ‘Global Reporting Initiative’sustainability reporting as a tool to implement environmental and social policies: A worldwide sector analysis. Corporate Social Responsibility and Environmental Management, 21(6), 318-335.
de Villiers, C., Rinaldi, L., & Unerman, J. (2014). Integrated Reporting: Insights, gaps and an agenda for future research. Accounting, Auditing & Accountability Journal, 27(7), 1042-1067.
Fernandez-Feijoo, B., Romero, S., & Ruiz, S. (2014). Effect of stakeholders’ pressure on transparency of sustainability reports within the GRI framework. Journal of Business Ethics, 122(1), 53-63.
Fonseca, A., McAllister, M. L., & Fitzpatrick, P. (2014). Sustainability reporting among mining corporations: a constructive critique of the GRI approach. Journal of Cleaner Production, 84, 70-83.
Hahn, R., & Kühnen, M. (2013). Determinants of sustainability reporting: a review of results, trends, theory, and opportunities in an expanding field of research. Journal of Cleaner Production, 59, 5-21.
Rahdari, A. H., & Rostamy, A. A. A. (2015). Designing a general set of sustainability indicators at the corporate level. Journal of Cleaner Production, 108, 757-771.
Vigneau, L., Humphreys, M., & Moon, J. (2015). How do firms comply with international sustainability standards? Processes and consequences of adopting the global reporting initiative. Journal of Business Ethics, 131(2), 469-486.